Structure of Derivative Markets

Derivatives are financial contracts whose value is derived from an underlying asset such as equities, commodities, currencies or interest rates. In India, the market is split into two distinct segments – exchange‑traded derivatives (ETD) and over‑the‑counter (OTC) derivatives. Each segment has its own set of rules, participants and risk‑management mechanisms.

The ETD segment operates on recognised securities exchanges like NSE and BSE. These exchanges provide a centralised order‑matching engine, standardised contract specifications and a clearing house that guarantees settlement. The OTC segment, by contrast, consists of privately negotiated contracts between two parties, often facilitated by banks or brokers, and is governed by bilateral agreements.

For the NISM exam, you must be able to map a given scenario to the correct segment, because advisory recommendations, margin requirements and disclosure obligations differ markedly between ETD and OTC.

• Standardised contracts → ETD
• Customised contracts → OTC

ETD contracts are listed on recognised stock exchanges such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). The exchange defines contract size, tick size, expiry dates and settlement procedures. This standardisation reduces negotiation costs and enhances liquidity.

All ETD trades are routed through a clearing corporation – for example, the NSE Clearing Limited – which becomes the buyer to every seller and the seller to every buyer. This “novation” mechanism eliminates direct counter‑party exposure and introduces a margin system (initial and variation margin) to protect against default.

SEBI (Securities and Exchange Board of India) regulates ETD through the Securities Contracts (Regulation) Act, 1956 and issues detailed circulars on position limits, margin methodology and reporting. In the exam, any question that mentions “exchange‑listed”, “standard contract” or “clearing house” points to ETD.

OTC derivatives are privately negotiated contracts that can be tailored to the specific risk‑management needs of the counterparties. Typical OTC products include forward contracts, swaps (interest rate, currency, commodity) and bespoke options.

Because there is no central exchange, the counter‑party risk is higher. To mitigate this, SEBI mandates that participants in the OTC market maintain a net‑worth requirement, report large exposures, and, for certain products, use a Central Counterparty (CCP) such as the Indian Clearing Corporation Limited (ICCL).

For exam purposes, note that OTC contracts are not subject to the same position limits as ETD, and the margin is usually negotiated bilaterally rather than imposed by a clearing house.

The backbone of the Indian derivative market consists of four pillars: the exchange, the clearing corporation, the depository (such as NSDL or CDSL) and SEBI. The exchange provides the trading platform, the clearing corporation guarantees settlement, the depository holds securities in electronic form, and SEBI oversees compliance and market integrity.

Clearing corporations maintain a default fund that can be tapped if a member defaults. They also calculate daily mark‑to‑market (MTM) and enforce variation margin calls. This infrastructure ensures that even in volatile markets, the system remains robust.

Advisors must be aware of these entities because they influence the cost of trading, the speed of settlement and the regulatory disclosures required for clients.

SEBI is the primary regulator for both ETD and OTC segments. Key regulations include the SEBI (Derivatives) Regulations, 2018, which prescribe margin methodology, position limits, and reporting obligations for brokers and advisers.

For ETD, SEBI mandates a minimum initial margin (often 5‑10% of contract value) and daily variation margin based on MTM. For OTC, the regulator requires parties to maintain a net‑worth of at least ₹5 crore for dealers and to report exposures exceeding ₹100 crore.

Advisors must disclose these regulatory requirements to clients, especially when recommending leveraged positions. Failure to do so can lead to penalisation under SEBI’s Code of Conduct.

Key participants in the Indian derivative ecosystem include investors, brokers, market makers, clearing members, custodians and the regulator. Investors may be retail or institutional; brokers facilitate order entry; market makers provide liquidity by quoting bid‑ask spreads; clearing members belong to the clearing corporation and post collateral.

Custodians hold securities in electronic form and manage settlement instructions. The regulator (SEBI) monitors compliance, while exchanges publish daily market statistics.

For the exam, you may be asked to identify which participant is responsible for margin collection (broker/clearing member) or who ensures daily settlement (clearing corporation).

Risk management in derivatives relies on daily mark‑to‑market, variation margin calls and a default fund maintained by the clearing corporation. If a participant’s MTM position moves against them, they must meet the variation margin by the next trading day.

SEBI also imposes position limits to curb excessive concentration. For example, a single entity cannot hold more than 5% of the total open interest in a given index future.

Advisors should incorporate these mechanisms into client suitability assessments, ensuring that the client’s capital can comfortably meet potential margin calls.

Recent years have seen the introduction of new contract types such as volatility index futures, currency options on the RBI‑approved exchange, and commodity derivatives on agricultural produce. SEBI is also exploring a central clearing model for certain OTC swaps to enhance systemic safety.

Technology upgrades, including blockchain‑based settlement pilots, aim to reduce settlement time and improve transparency. These developments may affect advisory recommendations, especially concerning product suitability and risk disclosure.

Exam questions may test your awareness of these trends by asking which new product is regulated by SEBI or how a proposed central clearing mechanism would impact counter‑party risk.